PE Firm Cerberus Capital’s “Rollup” Collapses into Bankruptcy

Bankruptcy becomes an increasingly common “exit.” And the pension obligations?

On Sunday, storied gun maker Remington Outdoor Co. filed for Chapter 11 bankruptcy, buckling under its debts. Its intention to file for bankruptcy has been known at least since February, but sources told The Wall Street Journal that the filing was delayed after the school shooting in Parkland Florida on February 14 that re-awakened the national debate on gun regulations.

As part of the deal negotiated beforehand, shareholders will hand over the company to secured creditors, which include Franklin Resources and JPMorgan Chase’s asset-management division. In turn, these creditors will forgive part of the company’s debt. When it’s possible to do so, the new owners will unload the reorganized company.

Among the largest unsecured creditors listed in the petition are the Pension Benefit Guaranty Corp., which is the US government’s insurer for failed private-sector pension plans, and the Marlin Firearms Company Employees Pension Plan. Remington had acquired Marlin Firearms in 2008. So the idea is that the restructured company will walk away from its pension obligations.

Who are the shareholders that are surrendering control?

Fund investors of PE firm Cerberus Capital Management. Cerberus acquired Bushmaster Firearms International in a leveraged buyout in 2006. In 2007, it acquired Remington, and later put them under a holding company, Freedom Group Inc., that also acquired other firearms makers, such as Marlin in 2008. Cerberus was doing a classic “rollup” in the firearms industry.

Those were the heady days of the fabulous leveraged buyout boom with its “Merger Mondays,” as CNBC used to call it – as many of the mergers were announced early Monday, similarly to bankruptcy filings.

In a leveraged buyout, the acquired company is made to borrow the money for its own acquisition and pay those funds to the acquirer, which uses those funds to pay off the bridge loan originally taken out to fund the initial deal. In other words, the acquirer has little or no equity in the deal, and the acquired company has been loaded up with debt. Hence “leveraged buyout.”

The plan was to sell this structure at a big profit to the unsuspecting public via an IPO. But months after the Marlin acquisition closed, the Financial Crisis blew into the open. Then came December 2012, when a gunman used a Bushmaster rifle to kill 20 kids at Sandy Hook Elementary School in Newtown, Conn. Nine families of victims brought a wrongful-death lawsuit against Remington, alleging it was liable for selling a weapon unfit for civilian use. The case is before the Connecticut Supreme Court, and with this decision hanging over the company, potential buyers completely disappeared.

Knowing that trouble was brewing, Cerberus separated Remington Outdoor — the name Freedom Group had already been scuttled — from its funds in May 2015 and opened a door for its fund investors to get out. At the time, the Wall Street Journal reported:

Cerberus sent a letter to its investors, which include pension funds and endowments, telling them that it has separated Remington Outdoor Co., the maker of Remington and Bushmaster rifles formerly known as Freedom Group Inc., from its funds and will allow any investor wishing to cash out of the company to do so, according to a person familiar with the letter.

The letter claimed that the company’s value, including debt, was about $880 million.

The deal to allow fund investors to cash out had a typical private-equity structure that has doomed so many companies: Remington used the proceeds from a 2013 debt sale to pay off equity investors. So the money the company had borrowed for operating capital was suddenly gone. And Sunday’s bankruptcy had moved a step closer.

Here’s the thing: If a PE firm cannot exit the LBO profitably, either by selling it to a deep-pocket corporation, or by selling it via an IPO, it is stuck with the company.

What causes a company to file for bankruptcy protection isn’t declining sales or thin profits but debt (and sometimes other obligations) that it can no longer handle. A PE firm could invest equity in the company to pay down this debt burden, and it could invest equity to improve the company’s operations. But that’s a not its job. Its job is to load up the company with debt, extract cash, and then “exit” via a profitable sale either to another company with deep pockets or to the public via an IPO.

When those two potential exits are blocked, the company is left to bleed out. And once the last drop of liquidity is gone, the company files for bankruptcy protection. This is the increasingly common third exit for PE firms from their LBOs.

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It’s parasites killing the host, with the blessing of the US government and tax code.

raxadian

Mar 26, 2018 at 1:19 pm

The answer is simple, don’t retire, work until you drop dead. Or move to a country with state pensions, even if they lower them, like Spain did, they cannot stop paying them.

As time passes it seems clearer and clearer that pension funds are a bad investment for future pensionists, sadly I have no answer what to do instead.

Harrold

Mar 26, 2018 at 1:41 pm

Boy are those policemen going to be mad when they find out their pensions are worthless!

Anon2017

Mar 26, 2018 at 3:34 pm

Canada means tested its Old Age Pension about 20 years ago.

The US hasn’t formally means tested Social Security, but it has effectively cut benefits for higher income seniors by instituting Medicare premium surcharges. The surcharges are not adjusted for inflation and the formula became more burdensome in 2018. Retirees with significant savings in their 401k/IRA and subject to Required Minimum Distributions from these accounts face an even bigger hit. I am very glad I retired early, started IRA withdrawals at age 60 and started to take Social Security at age 62.

By the way, if you move to another country, you are still stuck with the worst features of both countries’ tax codes. Even renouncing US citizenship can get very expensive.

raxadian

Mar 26, 2018 at 4:04 pm

Not saying you do that if you are about to retire but if you still have over thirty years to go? Worth it.

hendrik1730

Mar 26, 2018 at 4:46 pm

Build your own pension. Buy gold and keep it. And certainly don’t trust banks, pension funds, government, … nobody. You only need financial discipline – no debt, no mortgages, be your own man. You may have to postpone a lot of fancy things, but in the end, YOU will have a golden egg.

Frederick

Mar 26, 2018 at 10:35 pm

Now theres some good sound advice Thanks Hendrik

Anon1970

Mar 27, 2018 at 10:03 am

You may be able to get by without your government pension. But you will have a much harder time surviving in a country without law and order: think Iraq or Libya or Ukraine.

William

Mar 26, 2018 at 5:12 pm

The answer is simple, and often repeated: use leverage to improve your own life. Robert Kiyosaki put it in his popular book over a year ago. But assets like property and let someone else pay the mortgage while you keep the gains. When an average American has great credit and ability to squirrel away a few extra grand a year, the bank will practically gift them an extra low interest rate to use leverage in their own life, yet few Americans will take that gift.

Anon1970

Mar 27, 2018 at 10:09 am

Here is another take on Robert kiyosaki: slate.com/blogs/moneybox/2016/02/11/robert_kiyosaki_s_ongoing_legal_dispute_says_everything_about_the_shadiness.html

Also read the comments on that article.

Wander Lust

Apr 1, 2018 at 1:11 pm

Rent seeking at its finest.
It’s the American way.

WT Frogg

Mar 26, 2018 at 1:37 pm

Vampire Squid or what ?? Didn’t like the sound of the Remington deal back in the day.

There’s a good analogy between running a company and driving on the freeway in a fog. Financial leverage is like speed. On the freeway, the only safe speed is that of the cars around you. Go too fast and you crash; too slow and someone hits you. With corporate leverage, too little makes you a takeover target, and too much means bankruptcy when rates rise and you can’t roll the debt.

Trouble with pensions is that they are treated just like other corporate debts, even though they aren’t. The economy today would be better if pension obligations had been treated as super-senior debt, given top priority in bankruptcy. Boards and Execs simply should not have the power or ability to crash the company, leave all their employees in the ditch, and walk away with billion$. Let them do that to the rich creditors, who have the means to cope; not their workers and retirees.

MF

Mar 26, 2018 at 2:20 pm

Unfortunately, we live in a culture where people who work for a salary or hourly wage are considered chumps, while people who use their wealth (and the influence it confers) to steal from workers are lionized as demigods.

As long as this attitude persists, rich creditors will continue to take priority over pensioners.

Ed

Mar 26, 2018 at 3:45 pm

It is crazy. The pension is the most important promise management makes, together with warranties.

Courts ought to kick up a fuss about what led up to this situation.

michael w Earussi

Mar 27, 2018 at 10:22 am

Courts can be bought.

Daxx

Apr 1, 2018 at 6:03 am

Amen

Linezine

Mar 26, 2018 at 2:31 pm

Just stole the pensions from employees of a GUN company.

Lets see how this works out.

hendrik1730

Mar 26, 2018 at 4:48 pm

Now THAT is an interesting idea ….

mvojy

Mar 26, 2018 at 2:35 pm

Leveraged buyouts should be illegal. If you can’t go to a casino and gable with the house’s money and walk away when you bust then you shouldn’t be able to do it on Wall Street and with workers’ pensions. The divide between the working class and the wealthy is only getting bigger because of these practices.

Paulo

Mar 26, 2018 at 2:35 pm

re: “So the idea is that the restructured company will walk away from its pension obligations.”

As Gomer Pyle used to say, “Surprise, surprise, surprise”.

Pensions are just another form of deferred wage compensation, and are negotiated in good faith by employees. Unfortunately, many (if not most) private plans are in the hands of employers, who often raid the balance and leave just the minimum funds required. Or worse yet, LBO bandits make off with the money in dividends and returns.

My son works for a large multi-national in Oil Industry support. It is a union company and management is very supportive towards their workers. I was interested to see that the company pension plan is paid out for investment as part of their wage package, and that the company exercises a strict ‘hands off’ approach to pension fund control. He receives an extra $6.00 per hour strictly for pension contribution allowing him to invest as he sees fit. It adds up, for sure.

Kent

Mar 26, 2018 at 3:21 pm

Great comment. Pensions are just deferred compensation. And they are the employee’s compensation, not the employer’s. Underfunding or spending someone else’s compensation is called “theft”. There is no difference between taking your pension through bankruptcy and hacking your bank account and taking your savings. They’re the same thing. But this argument is about morality, not legality. Which is why our (American) prisons are filled with poor black kids and not rich white thieves.

Petunia

Mar 26, 2018 at 2:46 pm

Bankers with a legitimate excuse to run guns to shithole countries, financed at incredible margins. How lucky is that?

Javert Chip

Mar 26, 2018 at 4:59 pm

Actually, more than luck: Obama’s atty General Eric Holder was in on the gig.

Mary

Mar 26, 2018 at 7:23 pm

Making America Great Again, one bankruptcy at a time.

worldblee

Mar 26, 2018 at 3:09 pm

When I saw the declaration of bankruptcy, I immediately suspected PE was at work. Two seconds of research confirmed this and it’s great to read more details on WolfStreet. This fleecing of employees is really criminal in my mind. The legal system of the US provides cover for robber baron practices that literally take money out of the pockets of ordinary workers and retirees.

Scott

Mar 26, 2018 at 3:27 pm

The ownership was included in most of the articles; however Ceberus was given a less prominent role than litigation. This occurred in both right-wing (Fox) and liberal (Washington Post) media organization. however, I still don’t know the reason is it because they are trying to advance their position on guns, because they don’t want to blame private equity or because the reporters don’t know enough.

I too wondered about the litigation showing up so prominently in the bankruptcy coverage in the media. If I had had an answer, I would have offered it. But I’m not a bankruptcy lawyer.

Nevertheless, it seems to me that companies would wait with a bankruptcy filing until after it knows the outcome of the litigation and how much – if anything much – it will cost.

I also think (but I’m by no means sure) if a company files for bankruptcy protection before the judgement and the damage awards, the restructured new entity might still be liable.

If this is correct, then the litigation would have played only a minor or no role in the bankruptcy filing.

If there are any bankruptcy law experts who read this, please share your insights.

kam

Mar 27, 2018 at 9:33 am

There is plenty of law, both statute and common law, on fraudulent preference and fraudulent conveyance. In multi-million or billion dollar bankruptcies it usually comes down to judge shopping and hoping the creditors that get the haircut don’t appeal all the way to the Supreme Court.

Law cannot be easily divorced from economics.

Robert

Mar 29, 2018 at 10:05 am

A great article, Wolf, but when you write, “In a leveraged buyout, the acquired company is made to borrow the money for its own acquisition and pay those funds to the acquirer, which uses those funds to pay off the bridge loan originally taken out to fund the initial deal.” I did not understand how, since a company is obviously under stress to resort to this tactic, who would lend them the money to finance their own acquisition- can anyone explain? Thanks.

That’s the key question. Here’s the answer: PE firms build very tight relationships with banks. Banks make a lot of money in fees on these deals. So banks are eager.

These loans, as you said, are way too risky for banks. They’re called “leveraged loans.” You have seen this term many times on this site. Banks don’t keep them. They sell them to loan mutual funds or they slice and dice them and sell them as collateralized loan obligations (CLOs) to loan funds and other institutional investors, which buy them since they have a higher yield.

Also, much of this debt is sold as bonds into a bond-market bubble where anything goes. These are junk-rated bonds, and they yield a little more than high-grade bonds, but demand for this type of debt during a credit bubble is huge.

You cannot have an LBO boom without a credit bubble. Those two go together.

Daxx

Apr 1, 2018 at 6:18 am

I believe that if working people learn that the venerable politician (Americas VP) Dan Quail is this PE’s Chsirman of the Board, it will go a very long way at confirming the outrage we intuitively hold (aka Clinton Cash).

It’s truly disgusting that working people are mistreated at the time they are so economically vulnerable.

Update: It seems the litigation will survive the bankruptcy filing and will transfer to the restructured company after it emerges from bankruptcy. From the NY Times article:

” Susheel Kirpalani, a bankruptcy lawyer who has been consulting the Sandy Hook families’ legal team, said that he and others had been scouring Remington’s voluminous filings and disclosure documents, looking for anything in the complex financial transactions that might affect the Sandy Hook lawsuit. The company’s filings indicate that creditors, including the Sandy Hook plaintiffs, would be “unimpaired” by the Chapter 11 process, which means that the lawsuit can resume after the reorganized Remington emerges from bankruptcy.”

So the litigation very likely did not trigger the bankruptcy filing, and the media’s emphasis of the litigation might have been misplaced.

The media is very reluctant to blame PE firms when their portfolio companies collapse.

James Levy

Mar 27, 2018 at 6:41 am

On what planet, since Besos took over, is the Washington Post “liberal”? Hell, even before that these clowns cheered us into Iraq and spent every once of energy they had trashing Bernie Sanders and pushing the corporate globalist Clinton down our throats. If you want to call them establishmentarian, fine; Washington Consensus Democrats, just as accurate. Liberal? Not by any historical definition of the term.

Robert

Mar 29, 2018 at 10:02 am

Well, you are right there: the New York Times is the classical example of what is rearded as a “liberal” rag, but they have pounded the war drum at least since the 60’s, and have really been beating it in recent years as regards Russia, the Mid-East and Korea
They only had their Come-to-Jesus moment with the Pentagon Papers after the taxpayers’ carcass had been picked clean paying for Vietnam for 10 years.

Alistair McLaughlin

Mar 26, 2018 at 3:34 pm

Legal system in Canada allows for the same. Sears Canada just went under. Guess who gets the pension fund? The creditors, that’s who. As per Canadian law, companies can and do secure debt against their workers’ pension plans, and that means the pension assets go to the creditors in the even of bankruptcy.

A private member’s bill was introduced to Parliament recently by an NDP MP to change the law so that pensions are off limits to creditors, but the government quickly shot it down. The Conservatives – when they were in power – also dismissed similar initiatives.

Javert Chip

Mar 26, 2018 at 5:35 pm

My layman understanding of US law is most (not sure if all) pension funds are set up in a trust, and thud insulated from creditors. However, frequently, the trustees are corporate management (and they frequently adopt foolishly high investment return assumptions to lower corporate pension contributions).

The universal problem here is almost anything done to strengthen pensions is also an incentive for companies to cancel pensions.

I’d certainly support the following:

1) Employees voting to hire independent third party pension managers who could not be changed by corporate management. (However, this would not prevent chronic underfunding or total lack of funding when the company is under financial stress; obtaining this level of employee engagement would be difficult).

3) Pension funding should be super-senior debt, requiring payment in full before other obligations can be serviced (this has the effect of selling debt harder, and may actually force more into bankruptcy).

Javert Chip

Mar 26, 2018 at 5:37 pm

effect of selling other debt = effect of making it more difficult to borrow (eg: bonds, bank loans)

Prairies

Mar 26, 2018 at 5:51 pm

“The Conservatives – when they were in power – also dismissed similar initiatives.”

Wealth transfer isn’t a party issue, it’s a class issue. Liberals and Conservatives are rich and powerful, much like every other politician. At the moment there isn’t a system in place to correct the issue, the only bright side is that after a full year of Wolf calling out PE firms, the mainstream is starting to mention it. Maybe some wealthy infighting is about to start.

AC

Mar 26, 2018 at 3:29 pm

I wonder how long it will be before a destitute pensioner, ruined by a LBO scam, kills some of the ‘important people?’

When someone has nothing left to lose . . . . we might start seeing something approaching justice, at their hands.

Kent

Mar 26, 2018 at 3:34 pm

A short rant by Kent:

Liberty used to mean something good. At the time of our founding fathers, liberty meant the ability for a man to leave behind the predatory European (English) nobility. A man didn’t have to work another man’s land for minimal compensation. A townsman didn’t have to give up all of his hard work and labor to the local Earl for rent. He could come to America, cut a few acres out of the forest, build a farm and a living for his family, with no one’s hand in his pocket over which he had no control.

Today, liberty has become to mean license. License to put people in crippling debt. License to buy and rob good companies in the name of the free market. License to steal people’s pensions and future. License to put people in positions where they only have bad choices, and then blame them for making a bad choice. All the while profiting from it.

We have returned to the age of the predatory upper classes, and have been told this is liberty. It isn’t. It’s serfdom.

/rant

Dan Romig

Mar 26, 2018 at 5:11 pm

Kent, I totally agree with the first paragraph, and that is why I consider myself a ‘moderate member’ of the political party with Liberty in its name.

Unfortunately, there is license to buy and rob good companies if the companies are publicly traded. Of course the central banks’ interest free money has made this much easier. And the legal system in the US has allowed predatory business practices used by PE firms conducting leveraged-buyouts to run roughshod over workers and pension plans. I wish I had an answer to solve these problems.

The Founding Fathers were (and this is not an original description by me) basically a bunch of white male, slave-owning, hemp-growing Frat boys, but the Declaration and Constitution are the best set of rules to run a nation that humans have come up with I reckon.

Arnold Ziffel

Mar 26, 2018 at 3:46 pm

Worked for NYSE Medical Device maker that got bought out by a PE and debt leveraged 9 times EBITDA. Nice to get stock options cashed out but on the other side there were no pay raises, bonuses slashed, and benefits cut. Retired couple of years ago. The company is losing revenue due to 22 new manufacturers entering the space. It is in what I refer to as “death throes.” The PE game is based on odds of only 20% of the PE companies are ever successfully sold for a profit. A huge payout for the PE management and worth the odds of failing 4 out of 5 times.

Lars

Mar 26, 2018 at 3:49 pm

During a leveraged buyout the Pension liabilities MUST be planned for in advance of the take-over and pre-funded !!!

Gandalf

Mar 26, 2018 at 4:58 pm

Kent,

PBS has some excellent documentaries in its American Experience “The Gilded Age”, “The Mine Wars”, “The Bombing of Wall Street”. You can access them through Android TV – e.g. a paid service like WGBH Passport, or the older ones can be found online through a peer to peer network like tvunderground + emule downloader.

Or read a book about that period of time. They don’t teach this stuff in American History classes, anywhere.

Or read some statistics about who really owned the slaves before the Civil War (1% of the white Southerners owned 80% of the slaves. Over 3/4 of white families in the South owned no slaves. Plantation farming in the South was massively lucrative, accounting for 75% of US exports)

The bottom line is, the United States has always been an oligarchy or a plutocracy, controlled by the wealthy. All of the Founding Fathers who signed the Declaration of Independance were wealthy men.

At times, the power and abuses of this oligarchy has been far worse and more onerous than it is today – the wealthy 1% of the slave owning South pushed for seccesion and war, while mostly sitting out the war in the comforts of their plantations, making the poor whites who owned no slaves fight the war for them. “The Free State of Jones”, is an excellent movie, based on a true story, that does a great job of portraying this harsh truth.

The Gilded Age, the Mine Wars, were a period of much worse abuses by this oligarchy, which was what led to the Bombing of Wall Street. It was not until the upheaval of the Great Depression, and the election of FDR that the institutions of a socialist democracy were put into place.

Those institutions are being eroded today but imagine if they weren”t there at all

Rates

Mar 26, 2018 at 6:59 pm

Here’s my bright idea of the day. As part of trade deal with China, the later has to take 100% of the PE people in the United States. In fact I would make it the only condition.

I guarantee within 10 years, America will be great again.

Mike G

Mar 26, 2018 at 7:27 pm

Now THAT’S an act of economic warfare.

Rates

Mar 26, 2018 at 7:50 pm

I would call it Trumpian …..

In addition to PE people, I would also package the economists from the Ivy League in a one time only buy 1 get 2 free deal!!!

And as a special April only deal, we would also send over Yellen, Bernanke, Greenspan, the entire Clinton org, etc over!!

When it’s all said and done, I could be convicted for crimes against humanity itself!!!

Gandalf

Mar 27, 2018 at 1:59 am

Hold on a second there, everybody, including you, Wolf.

As much as I hate the greed and national economic disruption potential of the activities of the PE firms, and all the people they hurt, we need to take a step back and get some perspective on where they actually sit in this capitalist ecosystem of ours.

PE firms rarely if ever manage to kill off or asset strip vigorous, healthy businesses. In the Schumpeterian Creative Destruction/ Darwinian death struggle of the capitalist ecosystem, they are not the top of the food chain Apex Predators. No, they are merely the parasitic blood sucking worms and leeches and liver flukes that manage to further weaken already unhealthy/aging/dying animals in the ecosystem.

Toys R’Us was an Apex Predator once. It killed off all of its predecessors – the mom and pop shops that sold toys and hobbies and other five and dime stuff. In its prime it was the latest Hot Thing in our capitalist economy, transforming what had been a nation of small owner operated stores into gigantic specialty national chain stores with enormous buying power and the ability to price the mom and pop shops out of existence. Staples/Office Depot/Office Max did the same thing to mom and pop office and school supply stores.

I remember going to those mom and pop stores as a kid. I remember that there was a much better variety and better quality of goods back then, even if the stuff was slightly more expensive. I did not greet the arrival of Toys R’Us or Staples with great enthusiasm because I knew what we had lost, as a nation, with this shift over to gigantic national chains. Less selection, lower quality, all for lower prices.

The next Super Apex Predator that actually started the slide towards extinction for Toys R’Us was Walmart, when Walmart made its huge expansion in the late 1980s through the 1990s from small towns into multiple stores in every city in America. And then it expanded its Toy section. Walmart, not Toys R’Us became the single largest seller of toys in America. That was when Toys R’Us started its slide into extinction.

Amazon, of course, is now the Ultra Super Apex Predator and the Latest Hot Thing. The shift to online ordering from buying at bricks and mortar stores, together with the earlier hit from Walmart, is what really finished off Toys R’Us. Of course, along the way, Toys R’Us, in its weakened state, had gotten infected with killer parasitic blood sucking worms, the PE firms, and that was only going to ensure its extinction upon the arrival of the next Apex Predator.

Walmart wiped out or weakened entire swaths of businesses. It regularly decimated small town stores and businesses whenever it opened in a small town, from groceries to pharmacies to fabric and clothing stores. It crippled an already weakened KMart (which could have and should have been the next Walmart, except it made the fatal mistake during the critical time period when Walmart was expanding on its turf of hiring a crook/embezzler as CEO). It hurt Sears too. Recently, it has hurt Target by expanding upscale.

Walmart is now trying to fight off Amazon by moving into online sales in a big way. I have no idea how this battle ill turn out, but I can tell you that Walmart is giving it a good go – its online pricing is often better than Amazon.

Joseph Schumpeter called it Creative Destruction for a reason.

By the way, China does not need more blood sucking parasites in its economy. It already has a heavy burden of such parasites, the Communist Party officials who control every aspect of life and business in China. With the overturning of term limits for the Presidency of China, the healthy injection of new ideas and Creative Destruction that came with every new President is likely to stop and China is likely to become sclerotic with increased corruption and rigid thinking.

Bart

Mar 27, 2018 at 4:11 am

Gandalf,

When you say big box stores wiped out the little guy isn’t what really happened is the customers that used to shop at the little guy / local merchants voted with their pocketbooks to spend their dollars at big box stores?

Also, some 20 years ago Wal-Mart had a pretty significant campaign promoting “made in th USA” and when the consumer had a choice, the opted to save a few bucks and buy the coffee pot that was made in China.

It is often the case but not always that PE firms target weaker companies.

On a personal note I grew up in a small family business and was amazed when I first went to work at a large multinational at all the people on the payroll who didn’t seem to work very hard which to me is a different type of thievery but thievery none the less. Many of these long time freeloaders on corporate payrolls would not have lasted a day working as hard as my father did. Well run companies with proper headcount and good management are typically not prey for PE firms. I worked at one such company as well and the workday was longer and harder than the multinational but the job offered more security and money. Control your destiny or someone else will.

James Levy

Mar 27, 2018 at 6:49 am

How could those mom and pop stores have possibly controlled their own destiny, other than by organizing and using the government to block the destruction of their (extremely socially valuable) business model by Walmart et al.?

Gandalf

Mar 27, 2018 at 7:42 am

…. and you are right. A number of small towns have blocked Walmart from moving in to protect their small town businesses.

Gandalf

Mar 27, 2018 at 7:24 am

Bart,
My post is actually in complete agreement with you.

James Levy,
Large department stores have been around for over 100 years. The Big Box method of retailing did not move towards trying to sell cheap things to the masses until barcoding came about – this greatly reduced the labor involved in having to label everything in the store with a price sticker. Once that happened, the mom and pops, who were willing to work long hours with their families putting price stickers on everything in their store, lost their labor advantage to this cheaper technology

fajensen

Mar 27, 2018 at 9:34 am

…. the healthy injection of new ideas and Creative Destruction that came with every new President is likely to stop and ….

I think the Chinese see things differently:

China has had a lot of unimaginable bad experiences with new ideas and new leadership causing literally biblical (old testament stuff too) scales of destruction – creative or not. That is what they worry about preventing, to the point of building AI’s to enforce the proper Chinese values and social order.

And corruption – if it gets too bad, then one can get a trip with the organ-donor bus and that kinda places some limits on things.

Gandalf

Mar 27, 2018 at 2:56 pm

Deng Xiaoping was the one who put the 10 year term limit for the Presidency and Vice Presidency into China’s constitution. He wanted to avoid the Ruler for Life problems that came with Mao Zedong’s long rule.

Because China is a centralized control, command driven economy, every ruler of China has an enormous influence, good or bad, on what happens to the country. Mao had a lot of crazy ideas that only threw the country into turmoil, killed millions of people through famine, and destroyed much of the cultural history of China. Technologically, China did not advance any further than when the Communists took over in 1949. This went on for nearly three decades before Mao finally died.

Deng wanted to avoid the possibility of getting another such incompetent ruler of China for such a long period of time.

Because of the centralized control aspect of the economy, where all property rights are determined by the state, corruption is INHERENT to the system. Giving gifts of varying value to officials or superiors who have influence on the outcome of any business project is deeply ingrained in the system, indeed it is deeply ingrained into the entire history and culture of China, which has had nothing but authoritarian centralized governments since Emperor Qin Shi Huang in 221 BC. Gifting/bribes are definite requirements for getting anything done in China.

This is not uncommon in other Third or Second World countries, I should hasten to add, this need to give what would legally be regarded in the West as bribes to government officials to transact business.

So, when is a bribe not a bribe? Basically, if you are in the good graces of the Ruler and are reasonably discrete about these bribes, it is all OK, and it’s just the way things get done in China. Since everybody takes bribes, anytime the Rulers change or the Ruler decides he hates you, you can get put in jail or be executed for corruption, depending on how pissed off the Ruler is at you.

Xi Jinping’s anti-corruption campaign has been targeted primarily at his opponents and members of the previous regime. The purpose has been to put his own loyal men into all the government positions, consolidate his own power, reward his supporters like any good political patronage system would. Don’t think for one second that he actually cares about corruption. His own family is said to have reaped great wealth by now because he is the President. No, corruption has not changed for the better in China under Xi, only the people who collect the bribes have changed.

And that is the problem with a Ruler for Life. The cast of officials at the control points of the economy will have developed fixed relationships and business interests and if this cast of officials DO NOT CHANGE every ten years, then neither will the business interests, and technological advancements will not flow as freely, since established businesses will want to protect what they have rather than allow the Creative Destruction of a truly free capitalist system determine what is the best new efficient way of doing things.

And so, the Creative Destruction of capitalism, a term coined by Joseph Schumpeter, is what has allowed the often chaotic democratic societies with free capitalist systems to triumph over authoritarian command driven economies in the last 200+ years since the start of the Industrial Revolution.

Only free market forces, and a free flow of capital, unencumbered by the control points of bribed government officials, can truly determine which new technologies and new ways of doing things work best.

China, with its ten year term limits on the Presidency, came to approximate a sort of free flow of ideas in that every ten years, the cast of officials at the control points of the economy would get changed, which allowed the destructive creation of new business interests and new ideas. This will no longer happen with Ruler for Life Xi Jinping if his cronies stay in continuous control for three decades like Mao did.

fajensen

Mar 28, 2018 at 1:07 pm

Thanks for sharing your insights. True, that under authoritarian rulers “the system” is designed so that everyone must be guilty of something.

I think what is happening in China is that while the Chinese leadership value technological innovation for the power and wealth that it gives, they are also considering all forms of political innovation to be extremely dangerous. There is a boundary there, when technology change “the system” and becomes political.

The Chinese leaders see that innovative corporations are more and more running governments in the west and controlling the information and services used by society. They don’t want that to happen in China; they want to be on top of developments Now and control what is innovated so it is always aligned with the leadership goals.

One part of pulling this off, the Chinese intends to become the leaders in AI and the AI’s they build will be Chinese Patriots. Automation will allow them to cast all of their current society in IT-cement and never change even long after the current leaders and thinkers are all dead.

This is quite scary. If they somehow manage to engineer a true AI and they get it to “take off”, they will really have a 1000-year Reich (or whatever Mao called it)!

Gandalf

Mar 29, 2018 at 4:55 am

fajensen,

China’s deep underlying problems are not widely reported in the Western news media – so there’s just this obsessive focus on the competitive threats coming from China.

I can tell you that if China does become a world leader in AI and automation ….. its leaders will find themselves confronted by 1.3 billion unemployed and very unhappy people.

Dunno what the numbers are now, but not long ago, there were reports that Foxconn alone employed some 350,000 Chinese workers to make the iPhone for Apple.

Now, imagine that was all automated, and Foxconn shrank its workforce to 100 workers, or about one for every production line for the iPhone it has.

Now, imagine the rioting in the streets of China …..

Rates

Mar 27, 2018 at 2:15 pm

Not sure I follow. Are you saying that these companies would have gone away without PE due to competition, bad business practices, new ideas, etc? That much I can agree with, but PE makes the process of “going away” quite a bit worse. Let’s say the company would have gone under with 1 billion in liabilities. The PE guys would make that 2 billion easily and in the process they would gut whatever they can gut, suppliers, workers, etc.

Creative Destruction used to be the norm, but not anymore. Look at the sharing economy, it’s basically just serfdom with apps. No, we reached the peak quite some time ago. It’s pretty much downhill from now on.

China does not need more parasites? You want to make Murica great again or not?

Gandalf

Mar 27, 2018 at 3:15 pm

Rates,

PEs are like blood sucking parasites because they feed and enrich themselves off of the dying animal while it is still alive, and usually hasten its death. The animal (the corporation and all its suppliers and employees and its pension fund) does suffer a lot more because of this parasitic infection.

Think of bankruptcy court as the worms and soil bacteria breaking down the remains of the animal after it is dead. If a corporation manages to die without getting a PE infection, e.g., it just fell off a cliff, it is a cleaner, less painful death, usually

Gandalf

Mar 27, 2018 at 3:32 pm

.. for all the slings people make about Ubers and the sharing economy, you have to ask yourself, why does anybody become an Uber driver? Well, because like being a waiter, it’s a relatively low skill job that most people can do. Would you rather that these people just sit in the streets and do nothing, unemployed? That is what you see in some countries with high levels of unemployment. Lots of unemployed young me in the streets, staring at you

Uber is the Creative Destruction of the heavily regulated, city licensed taxi and chauffeur industries, harnessing the power of unemployed people with cars.

As for China’s Communist official parasites – they feed off of the beginning stages and healthy stages of a business enterprise. So they are a barrier to entry and a tax on businesses. They can absolutely hinder the process of Creative Destruction.

The PE’s accelerate the deaths of unhealthy businesses. That’s not great for the suppliers and employees, but this is part of the Creative Destruction process of capitalism

So, no, if you want to make Murica great, you want Xi in power forever making bad business decisions with his corrupt cronies hindering the growth of new technologies and ideas. You don’t want accelerated Creative Destruction in China.

Rates

Mar 27, 2018 at 4:35 pm

Gandalf. Why does anyone want to be an Uber driver?
1. Misleading marketing. 90K income per year according to Uber. This has been debunked obviously.
2. Uber drivers do not understand the economics of their own profession. They need to provide the cars, the insurance, etc out of their own pocket.
3. No choice. Despite the employment numbers, looking under the covers tells you that the employment is fragile. Income is stagnant.

You talk about parasites, but isn’t taking advantage of desperate people (no good jobs) with misleading advertisement, the behavior of one.

Xi Jin Ping is already taking the advice of Blackrock’s Larry Fink when it comes to stock market manipulation, which the Western world absolutely excels at and absolutely prevents Creative Destruction. If the West believes so much about Creative Destruction, then then should have allowed all those companies to go bust back in 2008 instead of doing the ultimate bailout.

Gandalf

Mar 27, 2018 at 9:50 pm

Rates,

I agree with everything you say.

Something like Uber could never work in the Good Olde Days of the 1950s and early 60s, the period that most Americans think of when they talk about Making America Great Again.

American industry was world dominant. Jobs were so plentiful in factories and other industries that black Americans could get jobs in cities and live middle class lives. Those black city neighborhoods that we think of as blighted crime and drug infested ghettos today were once nice middle class black neighborhoods! A total loser white male like Lee Harvey Oswald could repeatedly quit jobs after only a few months and still find another one, easily, including his final job at the Texas School Book Depository in Dallas.

The reason American industry was so dominant was not that it was better than any other country, it was just the only industrialized country left intact after the devastation of WWII. And we did a lot of that devastation.

So really, if you want to MAGA and go back to the 1950s, you would have to first bomb the industries of Europe, Britain, Japan, South Korea, and China into dust again.

So, yes, the world is intensely competitive now, jobs for low skill people are scarce.

You can go to college and get a useless and unemployable degree. I have one friend whose son went to college and got a degree in jewelry design. He was working as a waiter the last I heard.

So there’s working in a restaurant, and then there’s Uber. None of these are going to be permanent careers except for a tiny minority.

Bobber

Mar 27, 2018 at 10:15 am

Leveraged buyout strategies work because pension funds and other investment funds are forced to buy the crappy debt as a result of the Federal Reserve’s interest rate suppression policies.

This is a great example why central bank policies to suppress interest rates are harmful. Such policies might create some short-term benefits, like reducing unemployment, but in the long run it fails because of the systematic risks its creates, plus the negative impact of higher debt on growth.

Hope the Fed has now wised up, as a catastrophe is right around the corner if it restarts QE.

mean chicken

Mar 29, 2018 at 10:15 am

Sounds like legal fraud if nobody goes to jail? Moneyed interests doing what they do best; legally transferring wealth to themselves. That’s how these criminals make their living.

Ivan

Mar 30, 2018 at 12:12 pm

This phrase explains mechanics of leveraged buyout deals:
“In a leveraged buyout, the acquired company is made to borrow the money for its own acquisition and pay those funds to the acquirer, which uses those funds to pay off the bridge loan originally taken out to fund the initial deal.”

But could anybody help me to understand why the acquired company pays borrowed funds to the acquirer? For what? Thanks in advance.

Daxx

Apr 1, 2018 at 7:05 am

Pretty sure as compensation for the PE principles and investors.

The PE firms aren’t there to craft excellent operational businesses.

They are there to rape and pillage, albeit in a legal white collar professional rape and pillage definition.

mike smith

Apr 3, 2018 at 7:12 am

Cerberus has done the same thing with Albertson’s and now is about to steal Rite Aid by bribing the CEO to sell the company for 1/2 price. This debt laden mess with come to a crashing halt. Guess who will pay their unpaid pensions?

It’s the same mode of operation. Borrow to buy, extract all the possible cash, spin off the zombie company to die.